The Government has proposed a number of relaxations to the UK’s Insolvency laws, including an announcement that wrongful trading rules will be temporarily relaxed, retrospectively from 1 March 2020, for three months. Ordinarily, where a company continues trading where insolvency is likely, the company’s directors can be held personally liable for debts incurred whilst “wrongfully trading”. Understandably, Directors were concerned about the impact that trading through Covid-19 and the relaxation from the government will be a welcome relief to many.
What is Wrongful Trading?
Wrongful trading is a corporate offence whereby Director can be personally liable if a company has entered into an insolvent winding up or administration, and the director:
- Knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent winding up or administration; and
- Failed to take every step they ought to have taken with a view of minimising the potential loss to the company’s creditors
Where it becomes likely that insolvency cannot be avoided, directors must start considering the interests of creditors (in priority to the interests of the company’s members). For example, if a company continues to acquire goods or services from suppliers when it was unlikely that the company would avoid insolvency, this could constitute wrongful trading on the part of the Directors. A Director found liable for wrongful trading may be order to contribute to the company’s assets for the benefit of the creditors.
What does the relaxation mean?
The relaxation of the wrongful trading rules was introduced with the intention that companies can continue trading during the pandemic, helping them to potentially avoid a permanent shut-down, without the threat of personal liability for the Directors should the company ultimately enter insolvency.
Directors do still need to be mindful of their duties under the Companies Act 2006 (here) and the Insolvency Act (such as fraudulent trading) and so should still be trading carefully through the current climate.
Good practices that a company might consider implementing could include the following:
- Hold regular board meetings and keep detailed minutes of the decisions made and how creditors’ interests have been considered
- Consider whether taking on more debt to stay solvent now will be beneficial or not
- If new debt is taken on, record how the business is sustainable at that point
- Take specific advice on their particular situation
- Consider the impact of their duties under the Companies Act 2006 and the Insolvency Act as other provisions will still apply – including those dealing with transactions at undervalue or defrauding creditors
Quite rightly, companies will be taking advantage of the VAT deferrals available (this is automatic) and Time to Pay arrangements for other taxes as a routine method of extending cash resources. However, businesses should still be ensuring they have internal documentation (such as cash flows, board meeting minutes etc.) to evidence that there is a viable plan to repay these amounts in future.
Other proposals
The government also announced that the rules will add a moratorium for companies facing Covid-19 liquidity problems, giving them breathing space from creditors for up to 90 days while they undergo a restructure or rescue plan, and measures to enable them to continue trading in this period.
Draft legislation is yet to be released and so the detail on the changes is lacking at present – we hope that the return to parliament today will mean this detail will be released soon and we will update this article as soon as possible.
To Borrow or Not to Borrow
Companies and other businesses considering applying for a CBIL, or another form of financing should take a critical look at the position the company is likely to be once the UK comes out of the lockdown environment (whenever that may be). It can be a heart-wrenching decision to let a business fold, when it may have taken blood, sweat and tears to build up to its pre-pandemic position, but there may be circumstances when taking on further debt is not the sensible approach to take.
Businesses should prepare realistic cash flows based on various scenarios and evaluate whether additional finance will really solve the current cash flow crisis to see them through Covid-19, and whether they will be in a position to repay debts in the future. If the cash flow projections show the business is unlikely to be able to meet its debts for the foreseeable future, then it may be sensible for a difficult decision to be made now, rather than in the future when the business has accumulated higher debts, and creditors will be set to suffer greater losses. Once the dust settles, there will be opportunities to start new businesses, and in some circumstances this may be a better course of action to result in smaller financial losses for all.
Other ideas
Although borrowing funds seems to be the obvious solution when faced with an impending cash flow shortage, there are other options a business could consider such as:
- Merging with another business – this can be a way of cutting costs due to synergies and a combined business may be more resilient to the current challenges
- Selling the business – a planned exit via a sale may be possible
- Private equity investment – there will be investors looking for potential business opportunities. It may also be possible to structure this as an EIS investment for the investor, making it a more attractive proposition.
Seek Advice
Companies that are concerned about their solvency should obtain advice to help navigate and avoid potential breaches of the Insolvency Act or the Companies Act – including transactions at undervalue, fraudulent trading and preference transactions.
As ever, the Charter Tax team are on hand to help any business navigate these tricky times and to be sounding board for any ideas you may have to protect the longevity of your business. Please get in touch if we can help in any way.
